Investing

Why Dividend Investing is not a great idea

  • Last Updated:
  • Sep 24th, 2020 5:53 pm
Deal Addict
Oct 21, 2014
1456 posts
1799 upvotes
Burlington, ON
BardoonD52881 wrote: Why would you give money to company simply for them to return it. the whole point of a company going public is to generate capital to grow. once it cannot grow apparently the plow is to issue dividends to help investors do mental gymnastics into believing they arent risking their money but more so getting a paycheck every month/or so.
You aren't giving the company money when you buy stock in a company unless it's secondary offering or an IPO. Almost always you are buying an ownership interest in the company from another investor. Companies can and do continue to grow while issuing dividends, for example, Royal Bank has issued dividends for over 100 years and has grown significantly over that century..
Sr. Member
Feb 13, 2008
519 posts
220 upvotes
Edmonton, AB
rodbarc wrote: Not all of them do. Look at levered cash flow vs operating cash flow (or adjusted funds from operations) vs free cash flow.

It's fundamentals and the ability of large companies to create wealth by generating cash flow and increasing earnings that will increase the value of these companies.

Dividend paying companies that pay and increase their payouts cannot continue to do so if they are not creating wealth and cash flow, which is why I'm not afraid of market corrections.

Think of it this way...if you are investing in a company that pays a 4% dividend and has a history of increasing that dividend for say, 25 years...think the shareholders are going to be satisfied with less then what they have had over the previous decades of cash payments? Companies will grow in a sustainable way to continue the ability to provide that growing income.

In periods of market declines, when a dividend payer continues to pay dividends: if you do not need the income, and reinvest dividends, you are using said dividends to buy more of that company in which even in down periods you buy even more of it. That means you get more dividends in the future and more shares, and provided fundamentals stay solid (which can be monitored), you are buying a company that will reward it's shareholders with not only more income, but increased future share price as the dividend yield will go back to normal when the market correction ends and normal behavior returns.

Investing for retirement means you are building a business that pays you income to replace your earnings from work. Bonds at their current rate hold much more risk at .25%-4% current yields. It is not like bonds would not be punished if interest rates rose 1 or 2 % over the next few years as the Fed ends QE, and we return to normal interest rates in the range higher than today, depending on inflation.

So pick your poison...do you want to own a business that has a history of increasing its ability to generate capital? Or do you want to loan them money at historically low interest rates with no inflation hedge with and hope inflation is not ever going to increase?

Companies are not taking higher debt to grow dividends. Dividends come from cash flow, and unless a business have a growing operating cash flow, they can't keep growing dividends.

Higher debt doesn't always mean more problem. Companies use debt to fuel growth, which drives earnings higher. And stock price follows earnings. These companies, that are still investment grades, need to be looked individually, regardless of the economy or a bear market that is usually caused by a recession.

Here is why they shouldn't stop raising dividends to pay their debt:

First, the government encourages businesses to use debt by allowing them to deduct the interest on the debt from corporate income taxes.

Second, debt is a much cheaper form of financing than equity. It starts with the fact that equity is riskier than debt. Because a company typically has no legal obligation to pay dividends to common shareholders, those shareholders want a certain rate of return. Debt is much less risky for the investor because the firm is legally obligated to pay it. In addition, shareholders (those that provided the equity funding) are the first to lose their investments when a firm goes bankrupt. Finally, much of the return on equity is tied up in stock appreciation, which requires a company to grow revenue, profit and cash flow. An investor typically wants at least a 10% return due to these risks, while debt can usually be found at a lower rate.

These facts make debt a bargain. It would not be rational for a public company to be funded only by equity. It’s too inefficient. Debt is a lower cost source of funds and allows a higher return to the equity investors by leveraging their money.

So why not finance a business entirely with debt? Because all debt, or even 90% debt, would be too risky to those providing the financing. A business needs to balance the use of debt and equity to keep the average cost of capital at its minimum. This metric is called weighed average cost of capital or WACC.

There are hundreds of companies paying dividends for consecutive years, many raising them. Which ones, that have doing so consistently for years, are borrowing to pay dividends? You can identify it by reading their financial statements. It doesn’t last, and dividends gets slashed in a few months.


Rod
Thank you Rod for taking the time to explain and educate me. I have some mental health challenges since childhood which prevents me from understanding financial statements. I could not go further than Grade 8 in school. Fortunately, I was able to grow my portfolio to seven figures buy owning shares of Royal Bank, TD Bank, CN Rail, BAM.A, Enbridge, Starbucks, Amazon, Facebook, KO, Google, and so on.
Sr. Member
Feb 13, 2008
519 posts
220 upvotes
Edmonton, AB
MrMom, treva84, craftsman.

1) I read the threads daily but I do not always post my comments.

2) I have been called worse by more intelligent people.
Deal Addict
Aug 17, 2008
4287 posts
3426 upvotes
cocotheparrot wrote: MrMom, treva84, craftsman.

1) I read the threads daily but I do not always post my comments.

2) I have been called worse by more intelligent people.
I was wondering what I posted to offend you, so I started scrolling back. Surely if you read the posts daily, you would know that none of us or those who "voted" were even referring to you. LMAO now.
Deal Guru
Jan 27, 2006
14527 posts
7428 upvotes
Vancouver, BC
cocotheparrot wrote: MrMom, treva84, craftsman.

1) I read the threads daily but I do not always post my comments.

2) I have been called worse by more intelligent people.
MrMom wrote: I was wondering what I posted to offend you, so I started scrolling back. Surely if you read the posts daily, you would know that none of us or those who "voted" were even referring to you. LMAO now.
Exactly.

If I offended you by responding to your post about dividends being a ponzi scheme, please tell me how it offended you.
Member
May 4, 2010
215 posts
207 upvotes
Ottawa
cocotheparrot wrote: Dividend paying companies are a Ponzi scheme. They borrow money then pay it in the form of dividends!
cocotheparrot wrote: Fortunately, I was able to grow my portfolio to seven figures buy owning shares of Royal Bank, TD Bank, CN Rail, BAM.A, Enbridge, Starbucks, Amazon, Facebook, KO, Google, and so on.
So when are you going to cash out of your Ponzi schemes and go legit?
Newbie
Sep 15, 2017
17 posts
4 upvotes
I feel the same. Dividend investment goal is 'passive' income
rodbarc wrote: If my goal is income, I rather take the dividend, which gives me the option to reinvest or spend. If the goal is capital appreciation, I rather invest in growth stocks, that might or might not pay dividends. Different strategies, for different goals.


Rod
Deal Addict
Aug 26, 2004
1939 posts
133 upvotes
Toronto
2009M5 wrote: Not every company would benefit from re-investing their dividends.
Usually the industries that pay dividends are at their peak, they're not growth stocks, so investing in R&D/product development for the sake of it seems dumb.
If a project was on the table that was profitable, there is no questions they'd fund it, if it wasn't profitable - why fund it? Might as well pay a dividend.
Or they can buy back shares when valuations are right.
Deal Addict
Aug 26, 2004
1939 posts
133 upvotes
Toronto
2009M5 wrote: Not every company would benefit from re-investing their dividends.
Usually the industries that pay dividends are at their peak, they're not growth stocks, so investing in R&D/product development for the sake of it seems dumb.
If a project was on the table that was profitable, there is no questions they'd fund it, if it wasn't profitable - why fund it? Might as well pay a dividend.
Or they can buy back shares when valuations are right.
Deal Addict
Aug 26, 2004
1939 posts
133 upvotes
Toronto
Quentin5 wrote: So the lesson here is invest in the TFSA and reinvest the dividends inside the TFSA as well as top it up each year.
US dividends are taxed in a TFSA but not an RRSP
Deal Addict
Aug 26, 2004
1939 posts
133 upvotes
Toronto
treva84 wrote:
Also, isn't a buyback just another form of a company returning capital to it's shareholders, like a dividend? The only difference is instead of that cash being deposited into your brokerage account you see the buyback reflected in the share price.
KO increased shareholder ownership significantly in the past through buybacks.
Deal Addict
Aug 26, 2004
1939 posts
133 upvotes
Toronto
KO increased shareholder ownership significantly in the past through buybacks. Berkshire’s large stake in KO as a percentage of the company owned increased by over 30 % through KO buybacks (recall this from the Berkshire 1996 AGM I recently listened to). Had they Received this in a dividend thanks to taxes they would have had less overall.
Sr. Member
Feb 13, 2008
519 posts
220 upvotes
Edmonton, AB
introspect wrote: So when are you going to cash out of your Ponzi schemes and go legit?
1) I own Shell, BP, Suncor, and Exxon in my RRSP. As you are well aware three of them chopped their dividend. If I sell them I will lose my contribution room permanently.

2) I will sell the stocks in my margin account when His Majesty lowers the capital gain tax rate to ten percent!
Deal Addict
Jul 23, 2007
4138 posts
2214 upvotes
John Bogle had to learn the hard way the importance of dividends in a portfolio when managing Wellington Fund.

The 1967 annual report is quite different from the one issued in 1978.

Departing from Tradition—
Excerpts from the 1967 Annual Report
“Change is a starting point for progress, and 1967 was a year of change for Wellington
Fund. Obviously, times change. We decided we too should change to bring the portfolio more
into line with modern concepts and opportunities. We have chosen “dynamic conservatism” as
our philosophy, with emphasis on companies that demonstrate the ability to meet, shape and
profit from change. (We have) increased our common stock position from 64 percent of
resources to 72 percent, with a definite emphasis on growth stocks and a reduction in
traditional basic industries.
“A conservative investment fund is one that aggressively seeks rewards, and therefore
has a substantial exposure to capital growth, potential profits and rising dividends . . . (one
that) demands imagination, creativity, and flexibility. We will be invested in many of the great
growth companies of our society. Dynamic and conservative investing is not, then a
contradiction in terms. A strong offense is the best defense.”

------------------

Returning to Tradition—
Excerpts from the 1978 Annual Report
“We believe a greater emphasis on current income would enhance Wellington
Fund’s ability to meet the needs of its shareholders. Your Board of Directors has
approved a change in investment approach which will increase the amount of dividends
earned on the Fund’s common stock investments. This goal should increase the
likelihood of a growing dividend, and be accomplished without any material sacrifice of
“total return” potential (income plus capital appreciation).
“This strategy does not contemplate any change in the fund’s stock/bond ratio
(now 68 percent of assets), which will continue to represent between 60 percent and 70
percent of net assets. (The) additional investment income will be primarily generated
by orienting portions of our common stock holdings to higher yielding issues with
dividend growth potential . . . We launched a vigorous program for increasing current
income in the closing months of 1978, and plan to further increase the emphasis on
income in 1979.”

You can read about the whole sorry episode here.

http://johncbogle.com/speeches/JCB_WMC1203.pdf
Deal Addict
User avatar
May 11, 2014
4018 posts
4258 upvotes
Iqaluit, NU
cocotheparrot wrote:
1) I own Shell, BP, Suncor, and Exxon in my RRSP. As you are well aware three of them chopped their dividend. If I sell them I will lose my contribution room permanently.

2) I will sell the stocks in my margin account when His Majesty lowers the capital gain tax rate to ten percent!
1)Selling doesn't lose your contribution room forever. It already is "lost" in that it is down from when you invested. You only lose it if you withdraw. Selling stocks you don't want to hold is much better. Then you can reallocate the funds appropriately to your needs and wants

2)Unlikely to happen. Past and future ones won't. If anything there is more talks it will rise. And if you wait, you could face a larger one if you have to sell more shares and trigger it in a higher tax bracket.
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